Index Funds

Many 401(k) plans offer index funds as part of their investment menu, and these funds tend to be popular choices.

An index fund is designed to mirror the performance of a specific market index, such as the S&P 500 Index. If you believe that there’s no way for a mutual fund manager to consistently beat the market over the long term, you may prefer index funds to trying to select among managed funds.

In addition, index fund fees tend to be lower, sometimes significantly lower, than managed fund fees, because buy and sell decisions are based exclusively on changes in the composition of the relevant index so there’s no need for research or day-to-day investment decisions.

Of course, in a down market, an index fund will drop in value along with the index it mimics while some managed funds may achieve a stronger performance. That’s one risk of using these funds. Another risk is that many indexes—and therefore the funds that track them—are not as diversified as they seem. Because an index is typically weighted, a limited number of securities may determine the direction of the index. For example, the S&P 500 index emphasizes the performance of stocks with the highest market values.